In many organizations, managing and collecting Accounts Receivable (A/R) take a back seat to developing new sales. It seems obvious that high priority should be given to managing A/R — after all, why make the sale if you’re not going to get paid? Yet far too many business owners and managers blindly pursue the top line with insufficient attention to getting paid for their services.
There are three major steps to improving A/R management:
- Analyze/Diagnose the current state of accounts receivable
- Implement process improvements and proactive risk management
- Resolve and collect aging A/R accounts
To get A/R under control, the first step is to diagnose the situation. Carefully examine the current aging and trends over the past 6–12 months.
- Are your customers paying outside the payment terms? By how much?
- Have there been (or should there be) bad debt write-offs?
- Is there dilution of A/R from original invoice to eventual collection? If so, what are the root causes of these issues? (Causes may run deeper than credit and collections, such as quality problems or poor sales policies.)
- Is there sufficient attention paid within the organization to credit and collections?
Implement Process Improvements and Proactive Risk Management
Depending on the diagnosis, determine the root causes of collection issues and appropriate corrective actions. Typically, these actions either manage risk or improve the invoicing and collection process. Why emphasize implementing risk management and process improvements before collecting aging accounts? Because eliminating the creation of additional old A/R stops the bleeding. Without fixing the problem at the source, the company is chasing a moving target, as additional old accounts are continually being created due to failures of credit policies, customer selection, erroneous invoicing, or other flawed processes.
Resolve and Collect Aging Accounts
The sooner accounts are addressed, the better. Yet collections of old accounts are often deferred or the buck passed. Why? The answers are frequently behavioral:
- Collections mean dealing with problems, failures, and errors.
- Attempting to collect may result in write-offs.
- Collections just plain aren’t fun.
When attempting to collect an older account, the best result that can be accomplished is to collect what’s owed — and that best result may be viewed as just breaking even. Other results could include negotiating a lower amount, getting paid over time, losing a customer, dealing with a customer angry over product performance, or not getting paid at all. In most companies, these are thankless tasks. Most people prefer to be chasing the next order or the next deal than to get stuck dealing with collections.
If the problem is behavioral, then so are the solutions. Pay commissions, bonuses, or other incentives based on amounts collected, not on amounts invoiced.
Collections quickly become important when properly incorporated into incentives. Make A/R collections a key performance measure for the entire management team to track and improve. Other than resolving clerical details, never think of collections as a clerical task. It’s a management responsibility.
A critical component to managing the A/R is giving the appropriate attention to accounts that exceed 45 to 60 days. Don’t wait until they exceed 90. The moment a payment cycle is missed, unpaid and short paid invoices should be pursued. In the automotive world, a missed payment usually means something between the purchase order, invoice, and receiver didn’t match. Dealing with these issues immediately greatly increases the probability of collecting from the customer.
Cash Is King
A/R management will save resources and time in the long run. As root causes are identified, corrective actions should be implemented to ensure future prompt payments. Cash is king; without it, a company can’t survive. Devote the same priority to getting paid as to getting the order and delivering the product.
How We Helped — Attacking the Over 90 Beast
A client had a large amount of Over 90 A/R, which had built up over several years. This client had achieved success as a sales-driven organization; collections were something of an afterthought. P&M’s first step was to educate the client and raise credit and collections to a high priority.
The obvious solution was to apply extra resources to getting the Over 90 resolved and collected. However, every month another batch of A/R was aging. Any team working on Over 90 would be chasing a moving target.
For this client, the first priority was to stop the Over 90 Beast from growing. P&M helped the client identify and implement preventative measures, such as procedures to avoid pricing errors and mismatched POs and invoices. Fresh issues take much less time to resolve than old issues, so each month first attention went to resolving A/R in the 45-to-74-day range. The moving target was stopped, and the Over 90 balances were eventually reduced to an acceptable level.
For Your Consideration
Here are a few areas to consider when addressing A/R management:
- Know your customers’ credit worthiness.
- Only target new customers that are credit worthy.
- Diversify your customer base.
- Understand true credit norms in your market.
- Make sure credit terms are appropriate to your customers — both days to pay and maximum credit balance.
- Modify credit terms to those customers who are consistently paying late.
- Offer cash terms.
- Consider A/R insurance, especially for export accounts.
- Error proof pricing and invoicing.
- Upon shipping products or providing services, promptly/immediately prepare and send invoices to the customer. Not providing a timely invoice to the customer may cause delay in payment if the customer doesn’t recognize the payable until he/she receives the invoice.
- Make payment easy for the customer, through means such as accepting credit cards, electronic payments, and prompt payment discounts.
- Ensure cash is being posted timely and correctly to the accounts.
- Immediately resolve differences between invoices and customers’ remittance advice.
- Key performance measure — increase awareness and involvement.
- Align incentive compensation with collections.
- Address collections upon the first missed payment cycle — typically within 45 days.
- Deal with the old A/R realistically and proactively — negotiate, term out, trade, etc.